ESG Is too Big for One Board Committee. Even the Sustainability Committee.
By: Sarah Lockett, Director and Elizabeth Saunders, Partner
Take these 4 steps toward an integrated board oversight model.
Last year, we wrote about the importance of finding ESG a home, emphasizing the need to put it somewhere to overcome the ownership indecision holding companies back from furthering their ESG agendas. With board oversight being such a heavily weighted criterion for rating agencies, many companies acted out of necessity and made the easiest and most obvious choice. In a study by IR Magazine, 40% of North American companies reported that their nominating and governance committee has primary oversight of ESG issues. At 33%, the next-most common choice was the full board.
As with all things ESG, views on board oversight have matured.
The scope of ESG risks unique to a company and its industry has expanded and become more complex, extending across the entire organization, and impacting long-term business strategy. Regulation is playing a bigger role on the ESG stage. Expectations for reporting and disclosures are growing in response to newly proposed SEC rules.
And boards must adapt and allocate oversight for ESG topics accordingly. In other words, while somewhere is still better than nowhere, it’s time for companies to get much more strategic about where ESG is going to live. And the answer will likely be more places than one.
Today it is simply unrealistic for a single board committee to be sufficiently informed on all issues within the ESG universe to the degree necessary to execute their “duty of care” and make the best recommendations and business decisions around these issues. Even companies that have a dedicated Sustainability committee are realizing that the ESG issues—covering everything from climate change to data privacy to DE&I to over-compensated executive leaders—are much too broad to fall under one heading.
An integrated oversight model puts ESG matters in the hands of the committees best suited to deal with them.
EY noted that an emerging trend from the 2022 proxy season is that more companies are adopting an integrated oversight model for ESG matters. This approach can mean doing some work to redesign your board’s charters and corporate governance guidelines. But it is well worth the effort. Done right, it will give you a framework that can scale with the growing ESG landscape and keep you at the forefront of this critical issue long-term. Here are four steps to take to begin the transition.
1. Keep the pulse on ever-changing stakeholder and regulatory expectations for ESG oversight.
A good starting point is to tune into what your various stakeholders have to say on the issue while keeping in mind that this is constantly evolving. Fortunately, investors aren’t holding anything back. The top institutional investors including BlackRock, Vanguard, State Street, and JP Morgan have been extremely vocal about their expectations for board oversight of ESG issues and their views on how such practices signal strong corporate governance. Investors of all sizes and types are also proactively asking questions. Over the last 12 months, more than half (54%) of North American companies received investor inquiries related to the board’s governance structure and processes around ESG issues, according to a study by IR Magazine. If your investors are bringing it up, grab the opportunity to ask them what they would like to see.
Another place to look is at rating agencies and reporting frameworks. Most ESG rating agencies, including MSCI or Sustainalytics, are quite literally keeping score on the topic of board oversight. These organizations put significant emphasis on board engagement and reward companies in their scores accordingly. The proxy advisory firm ISS considers board oversight to be integral to every pillar of ESG. This company’s Governance QualityScore uses a methodology that expects human rights and ethical policies to fall within the board’s responsibilities while climate and cybersecurity risks are specifically called out as topics that require board oversight.
Of course, voluntary disclosure, at least in some areas, may soon become a moot point with the SEC’s new proposed rules requiring companies to include information about board oversight of climate and cybersecurity risks in their official filings. This includes naming the individual(s) and committee(s) responsible. Additionally, the proposed rules dictate that companies must have climate and cybersecurity experts on their board of directors to ensure proper oversight of these issues.
2. Use a materiality assessment to inform your risk management strategy and priorities at the board level.
It’s no small task to change the board charter and corporate governance guidelines. But having company-specific data to support recommended changes will help a normally difficult process go a lot more smoothly while providing the evidence that the changes you are making are warranted.
A materiality assessment takes your research of stakeholders’ ESG board oversight expectations to the next level. It is an exercise designed to scan and assess environmental, social, and governance issues that could impact your business. Ultimately the work narrows the list of potential issues to those that are highly relevant and unique to your organization with the greatest potential impact on your specific company and stakeholders. These insights will point you straight to the risk factors that require escalation to board-level oversight based on what your shareholders value most.
3. Identify logical alignment of issues and board committee objectives and redraft charters as necessary.
Once you have identified the ESG issues requiring board oversight, you can begin to assign them to the right committees. Here are some guidelines and examples that can help:
- The Audit and Risk Committee typically has experience with regulatory compliance and can ensure that ESG reporting and disclosures have the necessary controls in place to support their validity. In addition to reporting governance, more companies are placing data security oversight responsibilities with the audit committee as the threat of cyber-attacks is increasing. In a 2021 report by the Center for Audit Quality, 46% of S&P 500 companies assigned cybersecurity oversight to their audit committees.
- The Nominating and Governance Committee, as the name suggests, is uniquely suited to manage the governance pillar of ESG. These board members also have the authority to hold other board members accountable for ESG-related duties and can integrate ESG within board performance evaluations. The Corporate Governance and Nominating Committee at Intel reviews governance and corporate responsibility related to political contributions, environmental, sustainability, and workplace matters.
- Compensation/Human Resources Committee members typically have expertise in social topics including human capital, labor, diversity, equity, and inclusion, which are all important to a company’s ESG strategy. This committee is also responsible for setting proper incentives for executives including those that encourage executives to act on mitigating ESG risks. T. Rowe Price Group, Inc. has updated its Executive Compensation and Management Development Committee charter to provide guidance on diversity, equity, and inclusion initiatives on a regular basis.
- Environmental, Health & Safety Committee members are well versed in the systems, policies, and monitoring protocols companies have in place to protect resources and people. They can help oversee the company’s environmental impact and the corporate responses to it. At Con Edison, the Safety, Environment, Operations, and Sustainability Committee’s charter requires the committee to provide guidance on corporate policies and matters related to environment, health, and safety, including climate change.
- Technology/Innovation Committees oversee company strategy around emerging technologies and contribute to ensuring the company is following best practices in managing the privacy of its consumer base as well as in overseeing the societal implications of new technologies and products. Ford, for example, has a Sustainability and Innovation Committee that reviews and advises on strategies and new policies and technologies to ensure they promote product safety and improve environmental and social sustainability. Specific areas of consideration for new products include energy consumption, climate change, greenhouse gas emissions, waste disposal, water use, human rights, working conditions, and responsible sourcing.
- Sustainability Committee members (if you have them) may have deep ESG experience in many of the facets of ESG. Understand where their expertise lies while keeping in mind that other committees as well as corporate leadership need to share the load. Ideally, these committee members work hand in hand with management and members of the Audit, Nominating and Governance, and Risk committees to determine how key ESG risks are surfaced (i.e., by overseeing the ESG materiality assessment process) and how those risks are monitored on an ongoing basis. PepsiCo maintains a Sustainability, Diversity, and Public Policy Committee that oversees programs, policies, and risks related to these eponymous issues, while also monitoring public issues big enough to impact business strategy, operations, performance, or reputation.
4. Upskill your current directors, find new board members with the relevant ESG expertise, or engage a special advisor to close any gaps.
If you identify material ESG risks and currently do not have a board committee or individual board members with the experience to oversee that risk, there are a few strategies available to address the gap: upskill, acquire, or engage an advisor. Whichever approach you choose, use the opportunity to appropriately architect the board committees and define the processes for how committees will collaborate and support each other in your new integrated oversight model.
In a recent article about how to upskill boards to meet ESG expectations, the experts at Thomson Reuters outline the advantages of a multifaceted approach that leverages multiple, concurrent methods. For example, board members can be paired with internal experts (or external consultants) to learn firsthand the real and practical implications of ESG within the organization. While broad-based board-level ESG education is important, specific training tailored for each board committee can increase directors’ depth of understanding of the issues they oversee and ensure the nuances and complexity of those issues do not get watered down.
Sometimes, expertise will need to be found in new board candidates. You may have board-ready executives already within your organization with the requisite knowledge. However, climate risk experience can be difficult to find, especially as the importance of these skills and the demand for them rises. Industries with significant carbon footprints, such as energy, utilities, and manufacturing, tend to be most knowledgeable in this area. These might be good places to start looking for leaders who could be suitable for your board.
The board might also consider bringing in special advisors to review the proposed strategy, roadmap, and to help troubleshoot potential roadblocks. ESG advisors have deep technical expertise—particularly in the areas of climate risk, DE&I, and cybersecurity. Another advantage is the flexibility that comes with engaging an advisor. Rather than the longer-term commitment expected from a director, use advisors as long as it makes sense for your business.
Leverage every ESG advantage you can.
Rearchitecting your board committees to address ESG can be a considerable amount of work. However, it is work that will serve your organization well. And not just in terms of better ESG ratings or easier compliance, but also by ensuring you are using all your directors’ ESG expertise to your full benefit. If you’d like support as you think through adopting this new model for ESG oversight, give us a call. We can partner with you to conduct a materiality assessment, draft bylaws and committee charters, and ensure your board committees are organized to oversee and manage the full impact of ESG risks (and opportunities) for your business. Additionally, Clermont has experts that can serve as advisors to your board if you need to add expertise immediately.Back To Blog